ECB expected to cut rate to prop up Europe’s economies

FRANKFURT, Germany — Europe’s sinking economy and wobbly banks could get modest help Thursday from an interest rate cut by the European Central Bank.

Economists think the ECB will cut its benchmark refinancing rate by at least a quarter point to 0.75 per cent, a record low. On Tuesday, the rising expectation of a rate cut helped lift stock markets in Europe, which have been rallying since European leaders last week announced new measures to fight the continent’s debt crisis.

The ECB is likely to hold off from more aggressive measures, such as new cheap loans to banks. Its president, Mario Draghi, has said there is only so much the central bank can do and that it was up to Europe’s politicians to restore confidence in the 17-country eurozone.

European leaders agreed at a summit in Brussels last week to create a banking regulator under the ECB’s aegis with the power to rescue banks directly. The goal is to spare single governments from being overwhelmed by the costs of rescuing banks and to make it easier for them to access Europe-wide bailout funds.

The measures exceeded financial markets’ hopes and triggered a drop in borrowing rates for Spain and Italy.

Economic indicators have pointed down since the ECB’s last rate-setting meeting June 7, when Draghi conceded that there were risks to the bank’s forecast for a modest recovery this year. He also said a rate cut had been discussed at that meeting.

The ECB’s refinancing rate is what banks pay when they borrow from the ECB and therefore influences the cost of loans.

Marie Diron, an economist at Oxford Economics and an advisor for Ernst & Young LLP, said a rate cut was clearly warranted and would help confidence but might not increase growth that much.

“It will probably not help a great deal, but it will show that the ECB is on top of things, is aware of the potential severity of the situation, that the eurozone is shrinking and that the risks are on the downside,” she said.

A lower refinancing rate would reduce what banks are paying on the C1 trillion ($1.26 trillion) in 3-year, emergency loans that the ECB doled out on Dec. 21 and Feb. 29. Banks have been using that money to buy government bonds or other investments bearing higher interest, so a cheaper rate would increase their profits.

But that is about as far as the ECB is likely to go. Analysts think it will not issue more emergency loans to banks in part to keep a fire lit under governments to keep moving with reforms of their economies and of the institutional foundations of the euro.

Draghi has said the bank can’t make up for inaction by governments in combating the crisis. He expressed approval of the summit results, which has raised expectations that the bank will offer help, even though Draghi has said the bank does not engage in “horse trading” with politicians.

“New non-standard measures appear less likely,” wrote Commerzbank analyst Michael Schubert in a note to investors. “Firstly, the ECB wants to maintain pressure on governments and banks. The central bank cannot fill the vacuum that was created by a lack of measures by other parties.”

Surveys of purchasing managers in manufacturing and services indicate the eurozone economy is contracting faster than expected. The Ifo index of sentiment in Germany, the eurozone’s largest economy, has turned south, while analysts at Capital Economics say last week’s fall in the EU’s economic sentiment indicator would be consistent with contraction of the eurozone economy by a full 1 per cent this year.

That would be significantly worse than the relatively mild 0.3 per cent contraction foreseen for this year by the EU’s executive commission.

Other central banks are also expected to step in to support economic growth, which has been slowing across the globe. Analysts predict the Bank of England will reopen its program of buying government bonds from banks. The goal is to increase the amount of money flowing through the economy, improving banks’ ability to lend. The Bank of England’s policy committee will make a decision on Thursday.

In the U.S., the most recent economic data showed the manufacturing sector contracted for the first time since the country was in recession three years ago, fueling speculation that the Federal Reserve may consider more stimulus, as well. At its June policy meeting it said it would extend its Operation Twist, in which it sells short-term bonds and buys longer-term securities to push down long-term rates, until the end of the year using $267 billion.

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